Why You Should Contribute to a 401(k)

If your employer offers a 401(k) or similar retirement plan for their employees, this can be an easy way to save for your retirement. Here are some things to know about 401(k)s plans and some things to consider when deciding whether to contribute.

What is a 401(k) plan?

A 401(k) plan is a defined contribution plan offered by many employers. The employer, often in conjunction with a financial advisor to the plan, will offer a number of investment options that employees can invest in via salary deferral contributions. Some employers offer matching contributions and may make profit sharing contributions to the plan.

Defined contribution means that your retirement benefit is defined by the contributions made to the plan and how the investments you choose perform over time.

Traditional 401(k) account contributions are made with pre-tax dollars offering a current year tax benefit. Some plans offer a designated Roth account as part of their plan. The advantage of these Roth accounts is that there are no income restrictions on your ability to contribute as with a Roth IRA.

Most 401(k) plans offer a variety of investment options to choose from. These are generally mutual funds, but other types of pooled investment options are available in some plans.

Choices may include:

  • Money market or stable value funds
  • Stock funds of various types across a number of asset classes
  • Bond mutual funds
  • Managed funds such as target date funds
  • The ability to invest in company stock in some cases

Advantages of a 401(k) plan

There are a number of advantages to investing via a 401(k) plan.

  • Higher contribution limits than with an IRA. For 2022 the limits are $20,500 plus a $6,500 catch-up contribution for those who are 50 or over.
  • An easy way to dollar cost average.
  • Pre-tax contributions or Roth contributions (if offered).
  • Tax-advantaged growth of your investments.
  • A professionally selected investment menu among the best plans.
  • The opportunity of “free money” from employer matching if offered.
  • Wider creditor protection than an IRA.
  • Many plans have an auto rebalancing feature that allows you to rebalance your account in line with your desired asset allocation on a periodic basis.

Many plan sponsors take their fiduciary responsibilities very seriously and work with solid outside advisors and investment managers to ensure they offer top notch investments and that they keep expenses low.

Disadvantages of a 401(k)

  • An investment menu that is limited to what is offered in most cases.
  • If the plan is not well-run the investment options may be sub-par.
  • Restrictions on accessing your money if needed while you are working.
  • Not all plans offer low-cost investments.
  • Both traditional and Roth accounts are subject to required minimum distributions.

It’s important to understand what is both good and bad about your employer’s plan before investing, and to review the plan periodically over time.

The importance of consistently contributing to your 401(k) plan

The biggest reason to contribute consistently to your company’s plan is that this is an easy, painless way to save for retirement. The money comes right out of your paycheck, there is no need to write a check to the account. Once you get in the habit of contributing you likely won’t miss the money each payday.

Normally it is a good idea to contribute as much as possible up to the contribution limits each year. Even in a subpar plan, if the employer matches your contribution you will want to contribute enough to get the full match. This is free money, pure and simple.

Money in your 401(k) can be rolled over to an IRA when you leave the company, or to a new employer’s plan if allowed. This allows you to work with your advisor to manage these assets in line with the rest of your portfolio and to maintain the tax-advantaged status of this money.

Additionally, for those who want to accumulate more in a Roth account, there are no income limits on contributions. You can contribute up to the maximum contribution limits in any given year.

Contact your Wedbush advisor to discuss your company’s 401(k) and how to utilize it to your best advantage in light of your overall financial strategy.

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These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. The information in these materials may change at any time and without notice.